When stock markets witness dramatic swings, you may notice their effect on mortgage rates. While they are not directly connected, their foundation lies in the basic movement of the economy. It is like a series of circular chains that connect each entity together. While each are independent of each other, when one of them is affected, its impact can be seen on others too. The stock market is directly related to the bond market, and this, in turn, is directly related to the interest rate. The changes in interest rates affect mortgage rates.
A clear example of this is if interest rates change, people in the stock market may become on high alert, believing that such changes are about to affect stocks. This phenomenon also works in reverse, if stocks change drastically, the Fed may change their strategy to counteract the effects of the stock market by signaling change with their own new updated policy.
In this article, we will see this series of circular chains and how the stock market affects mortgage rates.
Relation between the stock market and bond market
To understand the relationship between the stock market and mortgage rates, you first need to understand the relationship between the stock market and the bond market. When things run smoothly in the economy, both stock prices and mortgage rates tend to be higher. They are both likely to fall when something hits the economy. When investors feel that there is a national or global financial crisis, they move their investment to a safer investment product like bonds to protect their money
Bonds are secured by the government and guarantee repayment, while the stock market has no guarantee. When investors invest in bonds, they are giving their money to the government and earning interest on it. However, the return on investment on bonds is lower, but at that point in time, investors are only concerned about the safety of their money. If they put their money in cash, they won’t earn anything as the cost of inflation actually reduces the value of their investment. For this reason, investors prefer investing in bonds so that they can at least get some return on it. The prices of stocks may even fall to zero, causing investors to lose all their investment, but a bond is a safer investment. Bonds and stocks are inversely connected; if one of them falls, the other often rises. As more and more investors start withdrawing their investments from the stock market and investing in the bond market, the stock market falls.
Bond prices influence mortgage rates
Investors pull their investments out of the risky stock market and jump to bonds. The increasing demand for bonds causes a significant increase in the prices of bonds and yields are likely to fall. Most consumer interest rates, including mortgage rates, credit card rates, and others, are measured against the 10-year Treasury bond. The fall in bond yields causes mortgage rates to fall.
Now you can see that the stock market does not directly affect mortgage rates, but they follow a similar movement pattern. It means that when the economy’s performance is poor, investors are likely to lose their investments in the stock market, but people can get a low interest rate on mortgages as the Fed will likely reduce rates to keep the flow of money in the economy moving. On the flip side, when the economy is soaring, an investor’s stock portfolio will also soar, but taking out mortgages will become more expensive. Rates will go up to prevent overheating of the market, which can cause inflation, a market correction, or both.
To predict the mortgage rate, you should observe 10-year Treasury bond yields, instead of paying attention to the stock market. Some other economic factors also influence the mortgage rate, including wage growth, inflation, unemployment rate, etc. Inflation measures are also important to keep track of. When inflation occurs, the Fed will typically increase rates to lessen the supply of money as most borrowers will reconsider getting a higher rate mortgage. Following the treasury bond yields and the stock market can be important in understanding the economy and can often be a good predicator of mortgage rates.